Before we go about trying to value natural-gas storage, we should try and come up with a list of important considerations in any valuation process. Also, the data requirements should be modest,...
Living on the Edge
Putting natural-gas price volatility into hurricane-season perspective.
The natural-gas and oil price run-up since hurricanes Katrina and Rita has subsided somewhat following a warmer than usual winter, record natural-gas storage levels, and successful conservation instituted by many gas and electric utilities in recent months. However, new sources of supply concern—such as occurred in Europe with accusations of gas-supply withholding between former Cold War adversaries—have rekindled calls for greater diversity of supply across Europe. Developments in the Middle East—especially in Iraq and Iran—and elsewhere in Africa also are lifting world oil prices through increased “security” premiums being sought by producers or traders holding long contracts.
For North American energy consumers, even such far away events indirectly affect energy market prices. In the current environment of razor-thin excess productive capacity margins for both oil and gas, even the slightest market hiccup abroad causes price volatility. For wholesale electricity prices, the run-up has driven up power prices across North America—again.
The warm winter—combined with record high prices—has caused a buildup of gas inventories in storage. The national storage levels as of Feb. 24, 2006, stood at 1,972 Bcf—48 percent above the five-year average of 1,331 Bcf for this time of year (see Figure 1) . This level also is more than 2 percent higher than the maximum five-year average of 1,921 Bcf.
For our May forecast update, Global Energy used NYMEX futures prices reported April 17-19. Global Energy forecasted Henry Hub prices to average $7.86/MMBtu during May and rise continuously thereafter until January 2007, when they will hit $11.74/MMBtu. The winter-summer differential, defined by Global Energy as the average price of December through February minus the average price from May through October, is $3.17/MMBtu. However, this winter-summer spread is expected to decline as storage inventories rise during the injection season ahead. As of the week ending April 14, national storage inventories stood at 1,761 Bcf, a buildup of 47 Bcf over the previous week’s level. Compared with the five-year average, working gas storage levels still are above historical norms and stand 62.6 percent above the five-year average. Despite the large gas storage levels due to lack of winter-related demand during the 2005-2006 winter season, U.S. gas-directed drilling experienced an increase in rigs used to help meet drilling demand.
Figure 4 shows the historical Henry Hub natural-gas prices, and Global Energy’s forecast monthly Henry Hub natural-gas prices.
During the winter of 2005-2006, Henry Hub spot natural-gas prices continued to trade at extremely high levels compared with most of the history of liquid natural-gas markets. Destroyed deliverability capacity caused by Katrina and Rita during the last quarter of 2005 pushed the market into uncharted territory for part of the winter. More recently, mild winter weather has moderated prices.
At press time, gas prices had returned to a contango (upward sloping futures prices) for the next year; however, prices